It's very common to get some raised eyebrows when I tell people to pump the brakes on paying off debt. I understand why someone might question this piece of advice: The first step toward paying off your debt is not paying off your debt.
Instead, the first step is building an emergency fund. Until you have $1,000 set aside for unexpected expenses, you only want to pay the minimum on all your debts.
That advice often seems counterintuitive if you feel burdened with debt. You may ask, “Why trade paying off a credit card with a 20% interest rate for a lower-interest-bearing savings account?” Mathematically, it makes zero sense. And if you're just looking at the numbers, it seems silly to put your money in an emergency fund.
But consider the alternative. If you don't have money in savings and you have an unexpected expense, you'll end up using that 20% credit card again, and then you're back at square one. It's extremely unmotivating, and it can end up taking you even longer to pay it off. The goal is to stop having to go into more debt to pay for upcoming needs.
In other words, your savings must come first to provide long lasting financial stability.
What's an emergency fund?
An emergency fund is a reserve of money you can easily get your hands on in the case of, well, an emergency. This could include things like new tires on your car or an unexpected medical expense. Maybe you'll have to replace your refrigerator or call an electrician. It's not a question of if you'll need it, but when you'll need it. It's meant for life's ordinary, unforeseen occurrences that fall outside your budget.
Many experts recommend having an emergency fund that covers 3 to 6 months' expenses. It's OK to start with less and work your way up over time. Setting $1,000 aside can help provide a buffer for many unexpected expenses.
Once you save $1,000, that's when I would recommend you more aggressively tackle your debt.
There are two strategies regarding which debts to pay off first. For a step-by-step guide on which one is right for you, read the article, How to get out of debt.
Once you get your debt under control — which doesn't necessarily mean you're debt free — you can start working toward 3 to 6 months' emergency savings. If you get a tax refund or work bonus, consider applying them to your debt to help you get there faster. The goal is not only to get out of debt, but also to stay out of debt. A fully stocked emergency fund is part of your long-term plan.
How can you change your habits?
To help get in the habit of saving rather than spending, you might try a strategy called "step-up savings."
Start by saving $1 the first week, and then build each week. The second week you save $2, the third week you save $3,and so on. Think those small increases won't add up? The result of step-up-savings 52 weeks later is $1,378 socked away.
It works because it can get you to shift your thinking. For an entire year, you're focused on directing your money to a savings account or, once it's funded, to a debt-repayment plan.
Try these other tips to help build your emergency fund.
Track your spending to identify nonessential purchases.
See where and how you're spending by using our online budgeting tool. Identify regular purchases you don't need and redirect that money toward your savings.
Set up an automatic transfer on payday.
You've heard the mantra "pay yourself first." Funnel a few extra dollars to your savings account before they're available. This way, you're least likely to miss them.
Take advantage of cash windfalls.
Whether it's a tax refund, extra income from a part-time job, a pay raise or a bonus, money that's not already accounted for in your budget is the perfect way to boost your savings. A lump sum increase to your savings is also a big motivator.
Start saving for your emergency fund today with a USAA Federal Savings Bank savings account.